Nordecon
Quarterly report

2017 first quarter consolidated interim report (unaudited)

This announcement includes Nordecon AS’s consolidated financial statements for the first quarter of 2017 (unaudited), overview of the key events influencing the period’s financial result, outlook for the market and description of the main risks.

Interim report is attached to the announcement and is also published on NASDAQ Tallinn and Nordecon’s web page (http://www.nordecon.com/for-investor/financial-reports/interim-reports).

Period’s investor presentation are attached to the announcement and are also published on Nordecon’s web page (http://www.nordecon.com/for-investor/investor-presentations).

Condensed consolidated interim statement of financial position

Condensed consolidated interim statement of comprehensive income

Condensed consolidated interim statement of cash flows

¹ Line item Cash receipts from customers includes VAT paid by customers.

² Line item Cash paid to suppliers includes VAT paid.

Financial review

Financial performance

Nordecon Group ended the first  quarter of 2017 with a gross profit of 624 thousand euros (Q1 2016: 1,153 thousand euros) and a gross margin of 1.5% (Q1 2016: 4.2%). The gross margin weakened year on year due to stiffer competition. We drew attention to the fact that changes in the market situation would put pressure on profitability already in 2016. We earned our first-quarter gross profit in the building construction segment although the gross margin of our Buildings segment dropped to 4.1% (Q1 2016: 10.7%). The decline in profitability is partly attributable to the loss of the Swedish subsidiary, which incurred some costs in the final stage of its first building construction contract which were not fully foreseen on entering the new market. Our results in the infrastructure construction segment were expectedly modest although the loss of our Infrastructure segment decreased compared with a year earlier. The main reasons for the segment’s loss were its lack of self-performed work (major earthworks, etc.) during the winter season and a large share of uncovered fixed costs.

Administrative expenses for the first quarter of 2017 totalled 1,457 thousand euros. Compared with a year earlier, administrative expenses grew slightly (Q1 2016: 1,292 thousand euros) but the ratio of administrative expenses to revenue (12 months rolling) decreased to 3.2% (Q1 2016: 3.6%). Although we made changes to the Group’s structure and continued investing in foreign markets which unavoidably and expectedly increases administrative expenses in the start-up phase, our cost-control measures continued to produce good results and we were able to keep administrative expenses below the target ceiling of 4% of revenue.

Operating loss for the first quarter of 2017 amounted to 992 thousand euros (Q1 2016: an operating loss of 213 thousand euros). EBITDA was negative at 503 thousand euros (Q1 2016: positive at 233 thousand euros).

During the period, the euro/Ukrainian hryvnia exchange rate was relatively stable and our exchange losses from adverse movements in the euro/Ukrainian hryvnia exchange rate were considerably smaller than a year earlier.  In the first quarter, the Ukrainian currency weakened against the euro by around 1.9%, which meant that Group entities whose functional currency is the hryvnia had to restate their euro-denominated liabilities. Exchange losses reported in finance costs totalled 49 thousand euros (Q1 2016: 291 thousand euros).

The Group’s net loss amounted to 1,086  thousand euros (Q1 2016: a net loss of 409 thousand euros), of which net loss attributable to owners of the parent, Nordecon AS, was 1,087 thousand euros (Q1 2016: 570 thousand euros).

Cash flows

In the first quarter of 2017, operating activities produced a net cash outflow of 6,647 thousand euros (Q1 2016:  an outflow of 2,818 thousand euros). Negative operating cash flow is typical of the first quarter and stems from the cyclical nature of the construction business. In the second quarter, larger fixed costs and preparations made for more active construction operations, particularly in the infrastructure segment, cause outflows to exceed inflows. In addition, operating cash flow is influenced by a mismatch between the settlement terms agreed with customers and subcontractors and the fact that neither public nor private sector customers are required to make advance payments while we have to make prepayments to subcontractors, materials suppliers, etc. We deal with equalising the settlement terms agreed with customers and suppliers on a daily basis, mostly through factoring. In addition to factoring accounts receivable, we have concluded a frame agreement for reverse factoring which enables our subcontractors who do not have sufficient credit standing to obtain a factoring limit from a financing institution to use our limit.

Investing activities produced a net cash inflow of 138 thousand euros (Q1 2016: an outflow of 88 thousand euros). The largest items were payments for property, plant and equipment of 33 thousand euros (Q1 2016: 103 thousand euros) and dividends received of 147 thousand euros (Q1 2016: 3 thousand euros).

Financing activities generated a net cash inflow of 2,640 thousand euros (Q1 2016: an inflow of 808 thousand euros). Financing cash flows were strongly influenced by loan and lease transactions. Proceeds from loans received totalled 3,430 thousand euros, consisting of use of overdrafts and development loans (Q1 2016: 1,562 thousand euros). Compared with a year ago, there was slight growth in finance lease payments which totalled 480 thousand euros (Q1 2016: 395 thousand euros). The rise in finance lease payments is attributable to large-scale investments in road construction equipment (including the acquisition of a new asphalt concrete plant) made in the second quarter.  

At 31 March 2017, the Group’s cash and cash equivalents totalled 5,917 thousand euros (31 March 2016: 4,236 thousand euros). Management’s commentary on liquidity risks is presented in the chapter Description of the main risks.

Key financial figures and ratios

Performance by geographical market

In the first quarter of 2017, Nordecon earned around 9% of its revenue outside Estonia compared with 7% in the same period last year.

The proportion of revenue generated in the Swedish market increased considerably compared with a year earlier. We continued to build two apartment buildings and started preparations for the design and construction of a third one. Although the proportion of revenue generated in Ukraine decreased, the amount of Ukrainian revenues remained comparable to the first quarter of 2016. In Ukraine, most of the revenue resulted from one large building construction contract. Our Finnish revenues resulted from concrete works in the building construction segment.

Geographical diversification of the revenue base is a consciously deployed strategy by which we mitigate the risks resulting from excessive reliance on one market. However, conditions in some of our selected foreign markets are also volatile and have a strong impact on our current results. Increasing the contribution of foreign markets is one of Nordecon’s strategic targets. Our vision of our foreign operations is described in the chapter Outlooks of the Group’s geographical markets.

Performance by business line

Segment revenues

We strive to maintain the revenues of our operating segments (Buildings and Infrastructure) in balance as this helps disperse risks and provides better opportunities for continuing construction operations in more challenging circumstances when the operating volumes of a sub-segment fall sharply.

Nordecon’s revenue for the first quarter of 2017 amounted to 41,604 thousand euros, a roughly 50% increase on the 27,731 thousand euros generated in the first quarter of 2016. Revenues increased in both the Buildings and the Infrastructure segment. The general contraction of the infrastructure construction market has also influenced our revenue structure. In the first quarter of 2017, our Buildings segment and Infrastructure segment generated revenue of 36,711 thousand euros and 4,487 thousand euros respectively. The corresponding figures for the first quarter of 2016 were 24,411 thousand euros and 3,108 thousand euros (see note 8). Our order book has a similar structure: at the end of the first quarter 77% of contracts secured but not yet performed was attributable to the Buildings segment (Q1 2016: 70%).

* In the Directors’ report, projects have been allocated to operating segments based on their nature (i.e., building or infrastructure construction). In the segment reporting presented in the financial statements, allocation is based on the subsidiaries’ main field of activity (as required by IFRS 8 Operating Segments). In the financial statements, the results of a subsidiary that is primarily engaged in infrastructure construction are presented in the Infrastructure segment. In the Directors’ report, the revenues of such a subsidiary are presented based on their nature. The differences between the two reports are not significant because in general Group entities specialise in specific areas except for the subsidiary Nordecon Betoon OÜ that is involved in both building and infrastructure construction. The figures for the parent company are allocated in both parts of the interim report based on the nature of the work.

Sub-segment revenues

In the Buildings segment, the strongest revenue contributors were the apartment buildings and the public buildings sub-segments where most of the Group’s revenue resulted from general contracting. In Estonia, a substantial share of our apartment building projects is located in Tallinn. In the first quarter, the main revenue contributors were the Meerhof 2.0 apartment building complex at Pirita tee 20a and apartment buildings at Kopli 4a, Kopli 6 and Virbi 10. The contributions of foreign markets sustained growth. In Ukraine, we continued to build a residential quarter in the city of Brovary in the Kiev region. In Sweden, we continued to build two apartment buildings and began preparations for the design and construction of a third, 8-floor apartment building in Stockholm.

We continue to build our own developments (reported in the apartment buildings sub-segment) in both Tartu and Tallinn. We have completed 5 apartment buildings in the first four phases of our Tammelinn project in Tartu and sales have been highly successful. By the reporting date, all completed apartments were sold. In the first quarter of 2017, we began building phase V which comprises a four-floor apartment building with 24 apartments and launched preparations for phase VI (www.tammelinn.ee). In phase V, which will be completed in August 2017, 23 of the 24 apartments are covered with pre-sale agreements or reservations and in phase VI, which will be completed in December 2017, around half of the apartments have already been reserved. In the first quarter, we completed the fifth and last terraced house in our Magasini 29 development project in Tallinn (www.magasini.ee). We continue to build two apartment buildings with a total of 30 apartments in Hane street in Tallinn. In carrying out our development activities, we monitor carefully potential risks in the housing development market that stem from rapid growth in the supply of new housing as well as a relative increase in input prices.

The key factor which influenced the results of the public buildings sub-segment was growth in the state’s investment in national defence. In the first quarter, we continued the design and construction of the Lintsi warehouse complex and the construction of a depot, infrastructure for armoured vehicles, a canteen and a barracks at the Tapa military base. In addition, we delivered to the customer Ugala Theatre in Viljandi.

The revenues of the commercial buildings sub-segment grew somewhat compared with the first quarter of 2016.  We continued to build the office and retail complex Viimsi Äritare and an office building at Lõõtsa 12 in Ülemiste City and to renovate the machinery hall of the historical Luther furniture factory into a modern office building. Based on our order book, we expect the commercial buildings sub-segment to post year-on-year revenue growth.

The revenues of the industrial and warehouse facilities sub-segment decreased year on year. The period’s largest projects were the construction of Harmet’s production and warehouse facilities at Kumna, near Tallinn, the construction of a co-generation plant at Kehra and phase III (fourth floor) in the reconstruction of the pig fattening unit of Rakvere Farmid AS (EKSEKO). We began preparations for building the Metsä Wood plywood factory in Pärnu.

For a long time, the main revenue source in the Infrastructure segment has been road construction and in the first quarter of 2017 its revenue contribution (compared to a year earlier) grew even further. We continued to render road maintenance services in the Järva and Hiiu counties and the Keila and Kose maintenance areas of the Harju county. The period’s road construction projects were small: we continued the reconstruction of Logi street in Tallinn and construction work at the Old City Harbour. A large share of the period’s revenues resulted from forest road improvement services provided to the State Forest Management Centre. We believe that road construction will remain the main revenue source in the Infrastructure segment through 2017. In contrast to the two previous years, when most of the segment’s revenues resulted from small or medium-sized reconstruction or rehabilitation projects, this year we have two large contracts:  construction of a 2+1 road (a road with passing lanes) on the Ääsmäe-Kohatu section of the Tallinn-Pärnu-Ikla road which was secured at the end of 2016 and reconstruction of the Haabersti intersection which was secured after the end of the reporting period in April 2017.

The contracts secured by the environmental engineering and other engineering (utility network construction) sub-segments are small and growth of the sub-segments’ revenues is unlikely. At the date of release of this report, there is no sign of any major hydraulic engineering projects to be announced and demand for other complex engineering work also tends to be irregular.

Order book

At 31 March 2017, the Group’s order book (backlog of contracts signed but not yet performed) stood at 130,109 thousand euros, an 8% increase year on year.

At the reporting date, contracts secured by the Buildings segment and the Infrastructure segment accounted for 77% and 23% of the Group’s order book respectively (31 March 2016: 70% and 30% respectively).

Compared with a year earlier, the order book of the Buildings segment has grown by around 18%. The order books of the commercial buildings and the industrial and warehouse facilities sub-segments have increased substantially, the first one primarily through contracts for the construction of an office building at Lõõtsa 12 and a multi-storey car par at Lõõtsa 11 in Ülemiste City in Tallinn and the Martens house in Pärnu. In the first quarter of 2017, we secured a contract for building a plywood factory for Metsä Wood in Pärnu, which increased the order book of the industrial and warehouse facilities sub-segment. The order books of the public buildings and the apartment buildings sub-segments have decreased slightly but the order book of the apartment buildings sub-segment is still the largest. The order book of the apartment buildings sub-segment is influenced by large contracts secured in 2016 including projects for the construction of the Meerhof 2.0 apartment building complex at Pirita tee 20a, apartment buildings at Virbi 10 and Sõjakooli 12, and five apartment buildings in the city of Brovary in the Kiev region in Ukraine. At the beginning of 2017, we secured a contract for building an eight-floor apartment building (Väsby Terrass) in Sweden. The largest contracts in the order book of the public buildings sub-segment are those for the construction of a depot, infrastructure for armoured vehicles, a canteen and a barracks for the Tapa military base.

Compared with a year ago, the order book of the Infrastructure segment has decreased by around 16%. 83% of the segment’s order book is made up of work awarded to the road construction and maintenance sub-segment whose order book has also decreased slightly compared with a year earlier. A major project in the road construction portfolio is the contract signed for building a 2+1 road (a road with passing lanes) on the Ääsmäe-Kohatu section of the Tallinn-Pärnu-Ikla road which was secured in 2016. We continue to provide road maintenance services in four road maintenance areas: Keila, Järva, Hiiu, and Kose. According to our estimates, in 2017 the volume of public investment will not increase substantially compared with 2016. Thus, we expect that in 2017 the revenues of the Infrastructure segment will remain more or less at the same level as in 2016 (for further information, see the Business risks section of the chapter Description of the main risks).

Based on growth in the Group’s order book and developments in our selected markets, we forecast year-on-year revenue growth for 2017. In an environment of exceptionally stiff competition, we have tried to avoid taking unjustified risks whose realisation in the contract performance phase would have an adverse impact on the Group’s results. Instead, our policy is to keep costs under control and monitor market developments with due care.

Between the reporting date (31 March 2017) and the date of release of this report, Group companies have secured additional construction contracts in the region of 33,263 thousand euros.

People

Employees and personnel expenses

In the first quarter of 2017, the Group (the parent and the subsidiaries) employed, on average, 716 people including 413 engineers and technical personnel (ETP). The number of employees, particularly the ETP staff, has increased year on year by around 10% in connection with growth in Group’s business operations.

Average number of the Group’s employees (at the parent and the subsidiaries)

Our personnel expenses for the first quarter of 2017 including all taxes totalled 4,479 thousand euros (Q1 2016: 4,109 thousand euros), a roughly 9% increase year on year. The growth in personnel expenses is mainly attributable to a larger headcount.

The service fees of the members of the council of Nordecon AS for the first quarter of 2017 amounted to 34 thousand euros and associated social security charges totalled 11 thousand euros (Q1 2016: 34 thousand euros and 11 thousand euros respectively).

The service fees of the members of the board of Nordecon AS amounted to 94 thousand euros and associated social security charges totalled 31 thousand euros (Q1 2016: 87 thousand euros and 28 thousand euros respectively).

Labour productivity and labour cost efficiency

We measure the efficiency of our operating activities using the following productivity and efficiency indicators, which are based on the number of employees and personnel expenses incurred:

The Group’s nominal labour productivity and labour cost efficiency increased year on year, mainly through revenue growth.

Description of the main risks

Business risks

The main factors which affect the Group’s business volumes and profit margins are competition in the construction market and changes in the demand for construction services.

Competition continues to be stiff in all segments of the construction market and in 2017 public investment is not expected to grow substantially compared with 2016. Thus, builders’ bid prices are under strong competitive pressure in a situation where the prices of construction inputs have been trending upwards moderately but consistently for several quarters. Bidders include not only well-known general contractors but also former subcontractors. This is mainly attributable to the state and local governments’ policy to keep the qualification requirements of public procurement tenders low, which sometimes results in the sacrifice of quality to the lowest possible price. We acknowledge the risks inherent in the performance of contracts signed in an environment of stiff competition and rising input prices. Securing a long-term construction contract at an unreasonably low price in a situation where input prices cannot be lowered noticeably and competition is tough is risky because negative developments in the economy may quickly render the contract onerous. In setting our prices in such an environment, we focus on ensuring a reasonable balance of contract performance risks and tight cost control.

Demand for construction services continues to be strongly influenced by the volume of public investment, which in turn depends on the co-financing received from the EU structural funds. Total support allocated to Estonia during the current EU budget period (2014-2020) amounts to 5.9 billion euros, exceeding the figure of the previous financial framework, but the amounts earmarked for construction work are substantially smaller. Projects supported by the EU began to have a limited impact on the construction sector in the second half of 2016 and in the next periods the process is expected to accelerate.

In the light of the above factors, we see some opportunities for achieving year-on-year business growth in 2017: business growth in Estonia is supported by positive developments in our selected foreign markets. Our action plan foresees flexible resource allocation aimed at finding more profitable contracts and performing them effectively. According to its business model, Nordecon operates in all segments of the construction market. Therefore, we are somewhat better positioned than companies that operate in one narrow (and in the current market situation particularly some infrastructure) segment.

Our business is also influenced by seasonal changes in weather conditions, which have the strongest impact on infrastructure construction where a lot of work is done outdoors (road and port construction, earthwork, etc.). To disperse the risk, we secure road maintenance contracts that generate year-round business. Our strategy is to counteract the seasonality of infrastructure operations with building construction that is less exposed to seasonal fluctuations. Our long-term goal is to be flexible and keep our two operating segments in relative balance (see also the chapter Performance by business line). Where possible, our entities implement different technical solutions that allow working efficiently also in changeable conditions.

Operational risks

To manage their daily construction risks, Group companies purchase contractors’ all risks insurance. Depending on the nature of the project and the requests of the customer, both general frame agreements and special, project-specific insurance contracts are used. In addition, as a rule, subcontractors are required to secure performance of their obligations with a bank guarantee provided to a Group company or the Group retains part of the amount due until the contract has been completed. To remedy construction deficiencies which may be detected during the warranty period, Group companies create warranty provisions based on their historical experience. At 31 March 2017, the Group’s warranty provisions (including current and non-current ones) totalled 1,176 thousand euros (31 March 2016: 1,137 thousand euros).

In addition to managing the risks directly related to construction operations, in recent years we have also sought to mitigate the risks inherent in preliminary activities. In particular, we have focused on the bidding process, i.e., compliance with the procurement terms and conditions, and budgeting. The errors made in the planning stage are usually irreversible and, in a situation where the price is contractually fixed, may result in a direct financial loss.

Financial risks

Credit risk

During the period, we recognised credit losses of 30 thousand euros. In the comparative period, there were no credit losses. The overall credit risk exposure of receivables is low because the solvency of prospective customers is evaluated, the share of public sector customers is large, and customers’ settlement behaviour is consistently monitored. The main indicator of the realisation of credit risk is settlement default that exceeds 180 days along with no activity on the part of the debtor that would confirm the intent to settle.

Liquidity risk

The Group remains exposed to higher than usual liquidity risk. At the reporting date, the Group’s current assets exceeded its current liabilities 1.01-fold (31 March 2016: 1.02-fold). The key factor which influences the current ratio is the classification of the Group’s loans to its Ukrainian associates as non-current assets and the banks’ general policy not to refinance interest-bearing liabilities (particularly overdrafts) for a period exceeding twelve months.

Because the political and economic situation in Ukraine is still complicated, we believe that the Group’s Ukrainian investment properties cannot be realised in the short term. Accordingly, as at the reporting date the Group’s loans to its Ukrainian associates of 8,716 thousand euros are classified as non-current assets.

For better cash flow management, we use overdraft facilities and factoring by which we counter the mismatch between the settlement terms agreed with customers and subcontractors.  Under IFRS EU, borrowings have to be classified into current and non-current based on contract terms in force at the reporting date. At 31 March 2017, the Group’s short-term borrowings totalled 17,504 thousand euros. After the end of the reporting period, we have refinanced short-term borrowings of 5,763 thousand euros, of which settlement of 3,913 thousand euros has been deferred to 2018 and settlement of 1,850 thousand euros has been deferred to 2019.

At the reporting date, the Group’s cash and cash equivalents totalled 5,917 thousand euros (31 March 2016: 4,236 thousand euros).

Interest rate risk

Our interest-bearing liabilities to banks have both fixed and floating interest rates. Finance lease liabilities have mainly floating interest rates. The base rate for most floating-rate contracts is EURIBOR. Compared with the same period last year, interest-bearing borrowings grew by 3,169 thousand euros. Both loan and finance lease liabilities increased (see also the section Liquidity risk). At 31 March 2017, interest-bearing borrowings totalled 23,649 thousand euros (31 March 2016: 20,480 thousand euros). Interest expense for the first quarter of 2017 amounted to 128 thousand euros (Q1 2016: 147 thousand euros).

The main source of interest rate risk is a possible rise in the variable component of floating interest rates (EURIBOR, EONIA or the creditor’s own base rate). In the light of the Group’s relatively heavy loan burden this would cause a significant rise in interest expense, which would have an adverse impact on profit. We mitigate the risk by pursuing a policy of entering, where possible, into fixed-rate contracts when the market interest rates are low. As regards loan products offered by banks, observance of the policy has proved difficult and most new contracts have a floating interest rate. We have entered into a derivative contract to manage the risks resulting from changes in the interest rates of the finance lease contract for the acquisition of a new asphalt concrete plant.

Currency risk

As a rule, the prices of construction contracts and subcontracts are fixed in the currency of the host country, i.e., in euros (EUR), Ukrainian hryvnias (UAH), and Swedish kronas (SEK).

The exchange rate of the hryvnia has been unstable because the political and economic environment in Ukraine continues to be complicated due to the conflict between Ukraine and Russia which broke out at the beginning of 2014 and at the beginning of 2015 the National Bank of Ukraine decided to discontinue determination of the national currency’s indicative exchange rate. In the first quarter of 2017, the hryvnia/euro exchange rate was relatively stable: the hryvnia weakened against the euro by around 1.9%. For our Ukrainian subsidiaries, this meant additional foreign exchange losses from the translation of their euro-denominated loans into the local currency. Relevant exchange losses totalled 49 thousand euros (Q1 2016: 291 thousand euros). Exchange gains and losses on financial instruments are recognised in Finance income and Finance costs respectively. Translation of receivables and liabilities from operating activities did not give rise to any exchange gains or losses.

The reciprocal receivables and liabilities of our Ukrainian and non-Ukrainian entities which are connected with the construction business and denominated in hryvnias do not give rise to exchange losses. Nor do the loans provided to the  Ukrainian associates in euros give rise to exchange losses that ought to be recognised in the Group’s accounts.

Due to movements in the Swedish krona/euro exchange rate in the first quarter of 2017, translation of operating receivables and payables did not result in any exchange gain or loss (Q1 2016: an exchange loss of 2 thousand euros). The prior period exchange loss was recognised in Other operating expenses.

We do not use derivatives to hedge currency risk.

Outlooks of the Group’s geographical markets

Estonia       

Processes and developments characterising the Estonian construction market

• In 2017, public investment should grow slightly but the extent to which relevant projects can be realised is still unclear. Although in the 2014-2020 EU budget period the support allocated to Estonia will increase to 5.9 billion euros (2007-2013: 4.6 billion euros), the portion that will influence the construction market will not increase. Instead, compared with the previous period, there will be a rise in allocations to intangible areas.
• In the context of the market as a whole, investments made by the largest public sector customers (e.g., state-owned real estate company Riigi Kinnisvara AS and the National Road Administration) which reach signature of a construction contract in 2017 will not increase substantially. The Ministry of Defence has been a positive exception for builders as its activities in carrying out new procurement tenders have made, and hopefully will continue to make, a significant contribution to market revival. Hence, the Estonian construction market as a whole (particularly infrastructure construction segments) will remain in relative stagnation. So far, the situation has been mitigated by the positive level of private investment in building construction but the latest developments reflect a certain slowdown also in the latter.
• The long and painful process of construction market consolidation will continue, albeit slowly. In particular, this applies to general contracting in building construction where the number of medium-sized general contractors (annual turnover of around 15-40 million euros) is too large. Based on recent years’ experience it is likely that stiff competition and insufficient demand will cause some general contractors to go slowly out of business or shrink in size rather than merge or exit the market. News about the difficulties of some construction companies, published at the end of 2016, show that the problems of weaker market players are escalating. According to our assessment, one reason why market consolidation has decelerated in recent years is customers’ (including public sector customers’) increasing desire to loosen tendering requirements to increase competition and lower the price even though this increases the risks related to security, quality, adherence to deadlines, and the builder’s liability.
• Competition is stiff in all segments of the construction market, intensifying in line with market developments. The rise in the average number of bidders for a contract reflects this. However, the gap between the lowest bids made by winners and the average ones is narrowing, which shows that the quality of procurement documents is gradually improving and bidders’ prices are evening up. It is clear that in the current market situation where the prices of construction inputs have started to rise efficiency is the key to success. Regrettably, the number of materials producers, suppliers, and subcontractors that are trying to survive or succeed in a difficult environment by dishonest means, e.g., by supplying goods with concealed defects or considerably lower quality than the one recorded in the product certificate, has increased quite rapidly. If the trend continues, both construction service providers and end-customers will have to apply strict and thorough quality control measures to make sure that the outcome meets their expectations. Unfair competition is putting visible pressure on prices and the quality of the construction service. Unfortunately, the problem is also underpinned by the customers’ (including state institutions’ and state-owned companies’) increasing tendency to lower the bidders’ qualification requirements and prioritise quality more on paper than in practice.
• In new housing development, the success of a project depends on the developer’s ability to control the input prices included in its business plan and, thus, set sales prices that are affordable for prospective buyers. Although new apartments are relatively expensive compared to the standard of living and the banks’ lending terms are strict, the housing market continued to grow also in the first quarter of 2017. At  the date of release of this report, there are signs that the market may be steadying. Hopefully the market will stabilise.
• There is a growing contrast between the stringent terms of public contracts, which require the builder to agree to extensive obligations, strict sanctions, various financial guarantees, long settlement terms, etc., and the modest participation requirements. Lenient qualification requirements and the precondition of making a low bid have made it relatively easy for an increasing number of builders to win a contract but have heightened the risks taken by customers in terms of funding, deadlines and quality during both the contract performance phase and the subsequent warranty period.
• In the second half of 2016, the prices of construction inputs, particularly in some specific building construction sub-segments  (e.g., finishing and concrete works, etc.), began to rise. So far, general contractors have been able to absorb this by making margin concessions but their capacity for doing this is decreasing. The construction market includes an increasing number of areas where changes in the environment may trigger a sharp price increase (e.g., materials producers’ rapid and successful entry into foreign markets). The rise in housing construction has lengthened the supply periods of various essential materials and services considerably, making it impossible to carry out all processes in the former optimistic timeframes. As a result, activities require more extensive planning or may need to be postponed.
• Persisting shortage of skilled labour (including project and site managers) may start restricting companies’ performance capacities, which may affect different aspects of the construction process including quality. Labour migration to the Nordic countries will remain steady and the number of job seekers who return to the Estonian construction market is not likely to increase considerably. All of the above will sustain pressure for a wage increase, particularly in the category of the younger and less experienced workforce whose mobility and willingness to change jobs is naturally higher.

Ukraine

In Ukraine, we provide general contracting and project management services to private sector customers in the segment of building construction. Political and economic instability continues to restrict the adoption of business decisions but construction activity in Kiev and the surrounding area has not halted. In 2017, we will continue our operations in Ukraine primarily in the Kiev region. Based on our order book as at the end of 2016, we expect that in 2017 our operating volumes will remain at a level comparable to 2016. Despite the military conflict in eastern Ukraine, for Nordecon the market situation in Kiev has not deteriorated compared with a year or two ago. Hard times have reduced the number of inefficient local (construction) companies and when the economy normalises we will have considerably better prospects for increasing our operations and profitability. The Ukrainian government’s recent crackdown on cash-in-hand work is definitely a step in the right direction, which in the long term should also improve our position in the Ukrainian construction market. We assess the situation in the Ukrainian market regularly and critically and are ready to restructure our operations as and when necessary. Should the crisis in eastern Ukraine spread to Kiev (which at the date of release of this report is highly unlikely), we can suspend our operations immediately. We continue to seek opportunities for exiting our two real estate projects which have been put on hold or signing a construction contract with a prospective new owner.

Finland

In Finland, we have provided mainly subcontracting services in the concrete segment but, based on experience gained, have started preparations for expanding into the general contracting market. The local concrete work market allows competing for projects where the customer wishes to source all concrete works from one reliable partner. Our policy is to maintain a rational approach and avoid taking excessive risks.

Sweden

We entered the Swedish market in July 2015, when we acquired a 100% stake in SWENCN AB, a company registered in the Kingdom of Sweden. In the Swedish market we intend to offer mainly the construction of residential and non-residential buildings, particularly in central Sweden. On gaining experience in the new market, we have prioritised quality and observance of deadlines and have therefore accepted a certain decrease in profitability. As regards our longer-term goals and the plan to build a viable and strong organisation that would compete successfully in the Swedish market, we are positive about the developments so far and see potential for sustaining business growth.

Nordecon (www.nordecon.com) is a group of construction companies whose core business is construction project management and general contracting in the buildings and infrastructures segment. Geographically the Group operates in Estonia, Ukraine, Finland and Sweden. The parent of the Group is Nordecon AS, a company registered and located in Tallinn, Estonia. In addition to the parent company, there are more than 10 subsidiaries in the Group. The consolidated revenue of the Group in 2016 was 183 million euros. Currently Nordecon Group employs close to 720 people. Since 18 May 2006 the company's shares have been quoted in the main list of the NASDAQ OMX Tallinn Stock Exchange.

         Andri Hõbemägi
         Nordecon AS
         Head of Investor Relations
         Tel: +372 6272 022
         Email: andri.hobemagi@nordecon.com
         www.nordecon.com